Chapter Three

1
Chapter Three
Consolidations Subsequent to the Date of
Acquisition
2
Consolidation - The Effects of the Passage of Time

• In Chapter 2, we looked at consolidation on the
  date of the combination was created.
• As time passes, the investment account changes,
  and the consolidation process becomes more
  complex.

3
SFAS No. 142 - Goodwill and Other Intangible
Assets
For fiscal periods beginning AFTER December 15,
2001, goodwill will no longer be amortized.
Any unamortized goodwill that arose from pre-SFAS
142 combinations will be henceforth carried on
the books as a permanent asset.
The nonamortization rule will apply to both
previously recognized and newly acquired goodwill.
4
SFAS No. 142 - Goodwill and Other Intangible
Assets
Generally, once goodwill has been recorded, the
value will remain unchanged.
5
Consolidation - The Effects of the Passage of Time

• The parent can account for its investment one of
  three ways
• Equity Method
• Cost Method
• Partial Equity

Lets compare the three methods briefly.
6
Investment Accounting
Exh. 3-1
7
Subsequent Consolidation - Equity Method
Before the consolidation balances can be
determined, the Parents investment account must
be adjusted to reflect the application of the
equity method.

• Record the Investment in Sub on the acquisition
  date.
• Recognize the receipt of dividends from the sub.
• Recognize a share of the subs income (loss).
• FMV adjustments and other intangible assets.

8
Consolidation ExampleEquity Method
On 1/1/05, Dad Co. purchases 100 of Kid, Inc.
for 900,000 cash. Kids net assets on 1/1/05 was
600,000.
9
Consolidation ExampleEquity Method
Before preparing the Equity adjustments,
determine the Goodwill and amortization expense.
10
Consolidation ExampleEquity Method
Amortization computation
Assume that Current Assets have a remaining
useful life of 1 year, and the buildings, has a
remaining useful life of 10 years.
11
Consolidation ExampleEquity Method
Amortization computation
12
Consolidation ExampleEquity Method
First, prepare the entry to recognize Dads share
of Kids net income. Dad owns 100 of Kid. Kids
Net Income 150,000
13
Consolidation ExampleEquity Method
14
Consolidation ExampleEquity Method
Second, prepare the entry to recognize Dads
share of Kids dividends. Dad owns 100 of
Kid. Kids Net Income 150,000
15
Consolidation ExampleEquity Method
400,000 dividends were paid by Kid to Dad during
the year.
16
Consolidation ExampleEquity Method
Finally, record the amortization of the fair
market value adjustments.
17
Consolidation ExampleEquity Method
The Amortization Expense from the earlier
computation 27,000
18
Subsequent Consolidation - Worksheet Entries

• 5 basic entries are posted to the worksheet.
• The Subs equity accounts are eliminated.
• The other intangible assets are recorded and the
  Subs assets are adjusted to FMV.
• The Equity in Sub Income account is eliminated.
• The Subs dividends are eliminated.
• Amortization Expense is recorded for the FMV
  adjustments and other intangible assets
  associated with the consolidated entity.

19
Consolidation EntriesEquity Method

• Entry S
• Eliminate the subs equity balances as of the
  beginning of the period.
• Plug the difference to Investment in Sub.

If (1) this is the first year of the investment,
and (2) the investment was made at a time other
than the beginning of the fiscal year, then
Preacquisition Income must be accounted for (see
Chapter 4).
20
Consolidation EntriesEquity Method

• Entry A
• Adjust subs assets and liabilities to FMV.
• Set up the Goodwill account and the other
  intangible assets. The difference is a reduction
  of the Investment in Subsidiary account.

In the first year of the investment, the FMV
adjustments for this entry will be identified
during the computation of Goodwill. In
subsequent years, the FMV adjustments and the
other intangible assets identified must be
reduced by any depreciation taken in prior
periods.
21
Consolidation EntriesEquity Method

• Entry I
• Eliminate the Equity in Sub Income account.
• Plug the difference to Investment in Sub.

22
Consolidation EntriesEquity Method

• Entry D
• Eliminate subs Dividends.
• Plug the difference to Investment in Sub.

23
Consolidation EntriesEquity Method

• Entry E
• Record amortization expense for the period
  associated with the FMV adjustments and the other
  intangible assets identified during the
  combination.
• Remember to never amortize land or goodwill!

24
Consolidation at 12/31/05Equity Method Example
Using the 12/31/05 adjusted balances, prepare the
consolidation at 12/31/05.
25
Note Dads updated numbers. Now, post the
consolidation entries to the worksheet.
26
(No Transcript)
27
(No Transcript)
28
(No Transcript)
29
(No Transcript)
30
(No Transcript)
31
(No Transcript)
32
Applying the Cost Method
If the COST METHOD is used by the parent company
to account for the investment, then the
consolidation entries will change only slightly.
Remember . . .

1. No adjustments are recorded in the Investment
   account for current year operations, dividends
   paid by the subsidiary, or amortization of
   purchase price allocations.
2. Dividends received from the subsidiary are
   recorded as Dividend Revenue.

33
Consolidation EntriesCost Method

• Entry S
• Eliminate the subs equity balances as of the
  beginning of the period.
• Plug the difference to Investment in Sub.
• This entry is the same under both the Equity
  Method and the Cost Method.

34
Consolidation EntriesCost Method

• Entry A
• Adjust subs assets and liabilities to FMV.
• Set up the Goodwill account and the other
  intangible assets. The difference is a reduction
  of the Investment in Subsidiary account.
• This entry is the same under both the Equity
  Method and the Cost Method.

35
Consolidation EntriesCost Method

• Entry I
• This entry is different under the Cost Method.
• Eliminate the Parents Dividend Income account.
• Also, eliminate the Subs Dividends Paid account.

36
Consolidation EntriesCost Method

• Entry D
• Under the Cost Method we DO NOT make an Entry D.

37
Consolidation EntriesCost Method

• Entry E
• Regardless of the method used, we must record the
  amortization of the purchase price allocations.
  This entry is the same as the Equity Method.

38
Other Consolidation Entries

• In addition to the Entries S, A, I, D, E, you
  must also eliminate intercompany payables or
  receivables.
• So far, we have assumed that the parent acquired
  100 of the subsidiary in the combination. If
  control acquired is lt than 100, an additional
  adjustment must be made (see Chapter 4).

39
Goodwill Impairment

• Goodwill is not amortized.
• It is assigned an indefinite useful life.
• Generally, goodwill will be carried at its
  acquisition cost.
• At some future point in time, the goodwill may
  become permanently impaired.

SFAS No. 142 calls for an annual test of
impairment for Goodwill.
40
Goodwill Impairment Examples
Exh. 3-15
41
Goodwill Impairment Test

• Step 1
• Compare fair value of REPORTING UNIT to carrying
  value of the REPORTING UNIT
• Step 2
• Compare fair value of GOODWILL to carrying value
  of GOODWILL

42
Goodwill Impairment Test - Step 1Is the Fair
Value of a Reporting Unit Less Than Carrying
Value?

• Compare the Reporting Units Fair Value to its
  Carrying Value.
• If Fair Value of the Reporting Unit is lt Carrying
  Value, GO TO STEP 2.
• Recompute Fair Value if the previous Fair Value
  can not be used?

43
Goodwill Impairment Test - Step 1Is the Fair
Value of a Reporting Unit Less Than Carrying
Value?

• Use the most recent Fair Value if
• The net assets of the reporting unit have not
  changed significantly since the most recent fair
  value determination.
• AND
• The most recent fair value determination gt the
  carrying amount of the reporting unit by a
  substantial margin.
• AND
• It is remote that computing a new fair value
  would result in an amount lt the current carrying
  amount of the reporting unit.

44
Goodwill Impairment Test - Step 2
If the fair value of a reporting unit lt its
carrying value, then Step 2 is performed. If
goodwills fair value falls below its carrying
value, then impairment has occurred, and an
extraordinary impairment loss is recorded.
Three Complexities Arise

• The assignment of acquisition value to reporting
  units
• The periodic determination of the fair values of
  reporting units
• The determination of the implied fair value of
  goodwill

?
45
Assignment of Acquisition Value to Reporting Units

• A Reporting Unit can be
• A component of an operating segment.
• A segment of an enterprise.
• The entire enterprise.

To better assess potential declines in value for
goodwill, the goodwill must be assigned to its
related REPORTING UNIT.
46
Periodic Determination of the Fair Value of a
Reporting Unit

• Basis for determining fair value
• Market price, if the reporting unit is publicly
  traded.
• Market price of comparable businesses.
• Business valuation techniques using PV.

47
Determination of the Implied Fair Value of
Goodwill

• Use the fair value of the reporting unit as the
  purchase price.
• Allocate the purchase price to all identifiable
  assets and liabilities of the reporting unit.
• Compare the resulting implied goodwill to the
  goodwill on the books.
• If implied goodwill lt recorded goodwill,
  impairment has occurred.

The implied fair value of Goodwill is
calculated in a similar manner as the
determination of goodwill in a business
combination.
48
Closing Observations Related to the Testing of
Goodwill for Impairment
Determining the fair value of the reporting
segment adds a new, potentially costly periodic
task of consolidated financial reporting.
The fair values of the assets and liabilities of
the reporting unit used in the test for
impairment do not impact the amounts reported on
the consolidated financial statements.
A decline in the value of the reporting unit does
NOT necessarily signal an impairment of goodwill
under SFAS No. 142.
49
Goodwill Impairment TestExample
Assume the fair value of Dad Co.s investment in
Kid, Inc. at 12/31/06 has fallen to 450,000. Is
Goodwill Impaired?
50
Goodwill Impairment TestExample
STEP 1 Fair value of the investment lt the
carrying amount of the investment, so go to Step
2.
51
Goodwill Impairment TestExample
STEP 2 The implied Goodwill lt the carrying amount
of the Goodwill, so an impairment write-down is
necessary.
52
Goodwill Impairment TestExample
Goodwill Impairment Entry The Goodwill needs to
be written down by 50,000. The entry should be
recorded as an extraordinary item on the
consolidated financial statements, if it is
material.
53
End of Chapter 3
This stuff is a breeze, aint it?